Concept of Profit Standard

Profit standards are determined in terms of the following: Aggregate money terms Percentage of sales, and Percentage return on investment. All these standards are determined for each product separately. Among all the forms of profit standards, the total net profit of the firm is more common than other standards. But when the purpose is to discourage the competitors, then the target rate of return on investment is the appropriate profit standard, provided the cost curves of competitors are similar. The profit standard in terms of ratio to sales is not an appropriate standard because this ratio varies widely from firm to firm, even they will have the same return on capital invested. These differences are following: Vertical integration of production process ntensity of mechani!ation "apital structure Turnover Setting the Profit Standard The following are the important criteria that are considered while setting the standards for a reasonable profit. 1. Capital-Attracting Standard An important criterion of profit standard is that it must be high enough to attract e#ternal capital such as debt and e$uity. %or e#ample, if the firms stoc&s are sold in the mar&et at ' times their current earnings, it is necessary for a firm to earn a profit of () per cent of the total investment But there are certain problems associated with this criterion, which are as follows: *. "apital structure of the firms such as the proportions of bonds, e$uity and preference shares, which affects the cost of capital and thereby the rate of profit. (. f the profit standard is based on current or long run average cost of capital or not. The problem in this case arises as it may also vary widely from company to company. 2. Plough-Back Standard This standard is appropriate in case company depends on its own sources for financing its growth. This standard involves the aggregate profit that provides for an ade$uate plough+bac& for financing a desired growth of the company without resorting to the capital mar&et. This standard of profit is used when li$uidity is to be maintained by a firm and a debt is to be avoided as per the profit policy of the firm. This standard is socially less acceptable than capital attracting standard. %rom societys point of view, it is more desirable that all earnings are distributed to stoc&holders and they should decide the further investment pattern. This is based on a belief that an individual is the best ,udge of his resource use and the mar&et forces allocate funds more efficiently. -n the other hand, retained earnings which are under the control or the management are li&ely to be wasted on low+earning pro,ects within a business firm. But to choose the most suitable policy among mar&eting and management the abilities of the management and outside investors are to be considered. This helps in estimating the earnings prospects of a firm. 3. Normal arnings Standard Another important criterion for setting standard of reasonable profit is the normal earnings of firms of an industry over a period. This serves as a valid criterion of reasonable profit, provided it should ta&e into consider the following points: Attracting e#ternal capital .iscouraging growth of competition /eeping stoc&holders satisfied. 0hen average of normal earnings of a group of firms is used, then only comparable firms are chosen. 1owever, none of these standards of profits is perfect. A standard should, therefore be chosen after giving due consideration to the e#isting mar&et conditions and public attitudes. .ifferent standards are used for different purposes because no single criterion satisfies all conditions of the customers.

Profit !anagement
0e have also studied that every business enterprise desires to ma#imi!e its profit. The condition for profit ma#imi!ation is the level of output where 2arginal 3evenue 4 2arginal "ost. 0e also differentiate between normal profit and super normal profit i.e. normal profit is included in average cost whereas any profit above the average cost is super normal profit. 0e have also considered the concepts of gross profit and net profit besides profit in accounting sense, which considers only e#plicit cost whereas in economic sense to consider profit we ta&e note of both e#plicit and implicit costs. The firm has also to reveal to its shareholders the profit before ta# as well as profit after ta#. After all, 5Business of businessman is business and therefore profit becomes the acid test of economic performance of any business enterprise. The aim is to ma#imi!e profit but if not ma#imum profit then at least certain satisfactory level of profit. 1owever, following factors relegate profit ma#imi!ation policy to the bac&ground: *. 6overnment interference : This has two aspects. %irst, there is always the threat of nationali!ation and second, the 6overnment may appoint a "ommission to scrutini!e the affairs of the company. (. Threat of entry of new firm i.e. if the firm ma#imi!es profit it automatically attracts new producers to enter the same area of operation which adversely affect its profit. 7. mage building or tarnishing of the image of the firm i.e. the firm does not necessarily wor& for ma#imi!ing profits but wor&s mainly to gain and retain the goodwill of the consumers or else it may be blamed for e#ploiting the consumers and therefore high profits may be loo&ed upon with contempt as a means of consumers e#ploitation and hence would become socially undesirable. 8. The firm would li&e to have a balance li$uidity and profitability. '. The firm will have to preserve good employer+employee relationship. 1igh profit may lead to trade unions demanding higher wages. 9. The business enterprise has also to maintain proper Balance :heet 3atios for the purpose of auditing as well as for upholding the interests of the shareholders. Thus, the above mentioned considerations relegate the policy of profit ma#imi!ation and hence the firm will have to be satisfied by earning ma#imum possible profits within the above mentioned constraints. Therefore, ma#imum possible profit without in any way tarnishing the image of the enterprise so as to serve and satisfy more consumers should be the ob,ective that should underlie the management of profits

Problems in profit measurement

+ 0hich profit concept to be used; + 0hat costs should be < what costs should not be included; = .epreciation = "apital gains < losses = "urrent Vs 1istorical costs > Assets? specially inventory > % %-, @ %- < 0A"